C (4:02)

This testimonial is being provided by Ted Cites and Capital Allocators who have been compensated a flat fee by wcm. This payment was made in connection with Capital Allocators, testimonial and production of podcasts and does not depend on the success or level of business generated. The opinions expressed are solely those of Capital Allocators and may not reflect the opinions of others. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. Please visit wcminvest.com for WCM's ADV and further information.

B (4:29)

Capital Allocators is also brought to you by Morningstar. What if data wasn't just a bunch of raw numbers, but a clear and decisive language to help connect investment strategies with long term investor needs in a constantly evolving market landscape? Morningstar created that language, bringing order and utility to insight rich data so you can prepare for your next opportunity, no matter the asset class or market. Visit wheredata speaks.com to see what Morningstar Data can do for you. Please enjoy my conversation with Adrian Meli.

D (5:08)

Adrian, thanks for joining me.

A (5:10)

Thanks for having me. It's always fun to spend time with you.

D (5:12)

Ted would love you to take me back to when you first got interested in investing.

A (5:19)

Yeah, let me think about this. I was born in Green Bay, Wisconsin and my parents separated when I was a couple years old and so my mother took me to upstate New York to live with my grandmother. In a twist of fate, she ended up meeting somebody pretty quickly thereafter and married my father who ended up raising me as his own. I mention it because it was formational in my life. So from there I moved to Massachusetts, to Georgia, to Texas. And I grew up in the South. My first dog was named Maverick. So I'll let you guess the city I grew up in. But it was really interesting. My dad had a few traits that really influenced my upbringing. He was a very hard working businessman who loved a good deal. And I say loved because sale wasn't enough. It was like a sale on a sale on a sale. It was everything we bought. You better believe the alarm clock was set for Black Friday early morning. We would go to auctions and I remember we bought pinball machines and we buy rugs. And just to show you how deep it went, one time we went to Disney World because there were Madame Alexander dolls that were very collectible and valuable, but each person could only get one. So me and my three siblings and my parents all waited in line for hours at Disney World to get these to pay for the trip. That was growing up. And all the games we played growing up were Monopoly and Acquire. My dad was ruthless. If you didn't make a trade with him, the next round he would raise the price $100. My mom would warn people off from playing against us because it was so ruthless. I don't know how much of it's genetic or environmental, but my parents will retell the stories of when I was a kid. In first grade, they got a call from the school because I had taken my birthday money and was buying all the Garfield folders at the school store and reselling them. And I think they were proud and thought it was funny. The next year was a little dicier because other parents were calling in to complain that I had started a trading booth and I was trading tchotchkes for my house, for their parents, jewelry and clocks. So that's how I grew up my whole life, doing things like this. And I ended up going to Williams College, which I had never heard of until I was a junior in high school and a kid a year older than me who I thought was so smart applied there. And I was like, hey, that must be a good school. So I applied. And in retrospect, when I got to Williams, I was pretty young, pretty green, pretty immature. Coming from Texas, I hadn't seen a lot of things in the Northeast. I had never heard of boarding school or I never heard of squash. I didn't know people had SAT tutors. I couldn't believe I was sitting in a group. I was like, you guys had A tutor. I got to grow up a little bit that was an econ psych major. And I love the way those two intersect in behavioral finance. And I ended up taking interest in investing and I wrote a paper about how hedge funds outperform mutual funds. So when I was offered a chance to join an investment partnership right at College in 2002, I jumped and put both feet in. It was just a terrific time to enter the world tied up. It's all the same for me. Whether I was buying Garfield folders or looking personally at buying hotels below replacement costs after the financial crisis or buying stocks today, I'm always looking for an arbitrage, a way to make money without taking much risk. And given the house I grew up with, what was important to learn along the way is the best deals aren't those unsellable teal crocodile loafers at the designer outlet on Black Friday that everybody is tempted to buy once or twice. It's those scarce few great assets that come on sale very seldomly that you got to jump at when you see the fun of it. For me, growing up today has always been the thrill of the hunt.

D (8:35)

What was that early hedge fund experience like right out of college?

A (8:39)

Oh, it was terrific and you know, because you were there. But I came out in 2002 and it was like drinking from a fire hose. It was just enormous alpha pool. The firm hired accounting professors from business school to teach me accounting. When I got there and I went right in. I still remember the looks on CEO's faces when a 22 year old in a floppy ill fitted suit would walk in so disappointed that they had to meet with me for an hour. But there was no LinkedIn. They didn't know who I was. I took the opportunity was like tons of field research. I would show up at annual meetings and harass business executives and board members. I would go to landfill hearings, I would pull court documents, just tons of stuff like that. After the dot com bubble burst, I got to do distressed debt, I got to do domestic equities, international equities, look at all sorts of different asset classes. But it was just really fun. And I was pretty tenacious about figuring out who the best investors were. I would hunt them down and I would try to figure out what they did and replicate it. I would go back on 13 Fs from three or four or five years lag and say, okay, let's go back to 1999, 2000. Why did this person make this investment? So it was really a great time to learn my takeaway. From that period was you had no talent there. It was early. That's why I got a job. They needed to manufacture young analysts. I wouldn't have gotten a job otherwise. You had a lot of aggressive, smart people in an unconstrained structure, in a huge alpha pool. You had a lot of large cap stocks that were overvalued, a lot of smid cap stocks that were undervalued. You had debt in pipelines and cable systems and cell phone towers and Enron bonds. Big alpha pool there and a lot of interesting spinoffs in special situations. The capital just hadn't flown in yet. What I took from it is, look, it doesn't seem like a coincidence to me that a lot of the best hedge fund returns in history were created from the late 90s to 2010, when that alpha pool was really big. Just a really great time to learn. Being in an unconstrained vehicle, working around smart people and getting to go meet with company after company.

D (10:33)

When you had that breadth of opportunity set and you're just a couple years out of college, how did you find your grounding to learn what it was you were looking for?

A (10:43)

So I don't want to overstate my skill in each area. If credit is a little too cheap, I'm not the guy to do it. What I'm always doing is looking for outliers in any asset class. Today, my partner, Alec Henry and I will follow late stage privates. I follow credit, I follow real estate, I follow assets all over the world. I think this is more of a generalist versus specialist approach. I grew up in a more of a generalist framework. If something is really dislocated, it's pretty simple to understand distressed debt. You're buying into a pipeline at a low multiple of earnings. If you think about this, you learn pretty quickly that you got to look at where money is flowing in and flowing away. So I would look at that period and say, hey, you had this great alpha pool. What happened? There's very low barriers to entry in the investment world. So big alpha pool, highly, highly remunerated profession. Hedge funds on the front page of the newspapers, TV shows about them, houses in the Hamptons, all this great stuff. What happens? People come to it, capital flows in, lots of competition gets in there, and all of a sudden those great gross returns come down and now they have a huge fee load on them. And so that created more efficiency. And you didn't used to have dedicated distress funds of the size you have today. The special situations were really interesting. The Joel Greenblatt stuff, you could see a spinoff. A big fund house would get a stock, sell the stock indiscriminately, and you could buy that cheaply. Later on in my career in that world, you could see that was getting priced more rationally. And so for me it was like, okay, capital's flowing here at very high fees. The returns are coming down, the net returns going forward to be lower. I'm not that skilled at a lot of things, but one of the things I think I've done pretty well in my career is trying to see around corners. It looked like to me the net returns were going to be lower.

D (12:23)

You're in the hedge fund, you've got this wide remit, you feel like the returns aren't going to be as interesting. What do you do when you're sitting in that seat?

A (12:33)

I really like my seat and I love that world. If you're lucky to have a good first employer like I did, where you can learn a lot, you'll learn things that you like and that you want to do differently over time. In this business, we're all wired genetically differently to be able to prosecute different opportunity sets. So I just had to learn over time where my skill set was, what I was good at. As I started thinking about it, it's like, look, what I really like to do is I'm trying to compound my own money and clients money. I want to align myself in interesting swim lanes where I'm going to be able to generate great returns. Maybe in hindsight it's obvious, but I think it was pretty clear at the time that if a lot of money flows into an area at very high fees, the future returns would be lower. So I started to think about what I want to do next. And my partner here, Alec, and I were talking about different opportunity sets. And I had the good fortune to meet the folks at Eagle had a terrific track record and I think an advantage structure. And I got to thinking about it, I was like, okay, let's think about fees in this industry as a cost of capital. If broadly the hedge fund world had higher fees and broadly this firm had more attractive fees, could we do the same thing? Why can't the net returns in this structure be higher than the other structure? Let's look at the single manager hedge fund world. What are they doing? I got to go to these great investor retreats with this family office that we're both friendly with. And you'd meet these amazing analysts. I was so impressed by all of them. I would listen to how they structure Their portfolios and their business. Your gross exposure is X and your net exposure is 60 to 80% and your fees are this. How is that going to work? You just have to add so much alpha to get a good net return. People in this industry are really smart and competitive. I didn't like having that cost of capital. Maybe I'm not as good as them. I like to have a lower fee. Maybe they have higher gross returns than I do, but maybe I can have higher net returns. Most of the great ideas in life are both non consensus and right. Plenty of ideas are non consensus is wrong. And so when I had the opportunity to get a senior role here and shift over, I found wouldn't it be interesting if I joined this world and I got to attack the swim lane of hedge funds that were higher fee and at the same time a lot of capital had left the long only industry and a lot of the talent had left the long only industry. Wouldn't it be interesting if over time Eagle were able to develop this reputation of hiring the same types of people and bring the same intensity or talent pool from the hedge fund world to this long only side at a lower fee structure? At the time it didn't feel so obvious. I joke around when we were at these retreats and Alec and my friend group at the time, I think almost every person was at a hedge fund. They would josh us a little bit, give us grief, like, hey, someday when you're wrong, you'll be able to come back to the hedge fund world. It's not obvious to people that you want to leave a very highly compensated structure and go to the lower fee pool. But we would laugh about it and it made our bet. In retrospect, it was non consensus and it worked out really well.

D (15:20)

Other than your friends making fun of you, what was it like to move from the hedge fund to the long only structure?

A (15:27)

It wasn't as different as you think. One of the funny things about the industry is everybody looks at somebody at a private equity firm or Citadel or a hedge fund or long only and thinks they're so different. They're the same people, they're just moving around seats. You meet somebody from Citadel, they have some of the best analysts in the world or Millennium. You meet somebody from a top single manager hedge fund, they're some of the smartest people you've ever met. You meet somebody from a top mutual fund, they're some of the smartest people ever met. But what was clear was that the competition set when people were looking at us was easier that was very obvious from day one, a day before. You're up against all these great people that had these great 20 plus percent return streams for the last 10 years. And you're like, oh, should I give money to this firm versus that firm? And then you come here, I'm comparing you to this big mutual fund house. From a relative basis, it gave us an interesting opportunity set to attack because the competition set were worse. But if you look at duration, the pejorative term for long onlys at the time, and I think still people think this is like an asset gathering business and lazy capital, they would say people would use the term time arbitrage. The joke was I just underperformed short term, but that's deferred alpha. And so that's why all the capital was seeking hedge funds. Because they saw this talent intensity of research there. The key was could you bring that intensity of research to this structure? So imagine the business model of an eagle. We have 25 to 35 securities, we have eight people on the analyst team and you hold the security for six years. That would mean you only really need to buy four or five or six new securities a year. What if your business model was you've got all these pockets of talent trying to get at least spin off special situations at higher fees. What do they have to do to charge higher fees? A lot of times you end up in more levered businesses or higher growth businesses. And so imagine you found a very low risk, 12 or 13% IRR. It's very hard to buy that in that structure. And around that time during the financial crisis, there were so many interesting opportunities, converts were cheap or lots of interesting stocks, TARP warrants, there were a lot of stuff afterwards. It looked to me and Alec like the opportunity set was more in these bigger scale companies that people now call compounders. People weren't really looking out five to seven years on them. The way we conceptualize is if the business model is we got a large number of analysts, we got to buy circa five new stocks a year. That's less than one new name per analyst a year. Theoretically in this structure, how much time, energy and research can we do to get each new opportunity? And can we bring the intensity of the hedge fund side but the patience of a long only side and marry the two. And so that's what we've tried to do here.

D (17:59)

As you built out that team, the concept of maybe you can bring that hedge fund intensity to the long only world. How did that work over the years from when you first came to Today.

A (18:09)

Eagle was a terrific firm before I got here. And if Alec and I do our jobs well, it'll be a terrific firm when we leave one day. The first principles analysis of this industry are low barriers to entry enormously talented people. If it's not the most competitive industry in the world, it's certainly one of the few most competitive industry in the world. If your strategy is let's just be the smartest guy in the room and you want to create a structure on that, that's not going to work. That would be impossible. What we tried to do is build Eagle to have some competitive advantages. And talent is one part of that. I'd like to think we've built up some barriers here that have gotten bigger over the years or a right to win as I would call it is first. The firm was built over 35 years ago. It has duration in its bones when all the founder cared very much about that. The investment time horizon we hold a stock for over five years on average. We model companies out five to seven years looking at normalized free cash flow and earnings per share. We've had clients with us for many years. They trust us to think long term. We have an average client relationship circa 10 years. The client base is diversified by end market, endowment, foundation, pension, high net worth, sovereign. All of those actors can act differently at different times. This all creates ballast and duration into the model. In a world that's become more short term, that duration is a growing competitive differentiation. But we built it more into the organization than just that. On the investment side, none of the analysts are paid bonuses that are all paid salary. We want them to be focused on duration. And it's all built around an investment partnership. There's a number of partners at Eagle. We all live and die by the performance of the fund. If we have a bad numbers, there's no reason for us to exist. So we all eat the cooking together. I'm heavily invested in the strategy. Alex heavily invests in the strategy. And we're compounding our own money along with clients. And we do that on a fund basis in terms of the stock picking. But also we do it organizationally. If we've been around for 35 years, we think we have an opportunity to be around for the next 10, 20, 30 years. So we're hiring, attracting and recruiting talent to continue to build that. And so you asked about talent. That has singularly been the most fun thing about working here is that watching that talent density grow over the last 17 years. Look at our team. If you looked at their bios, top hedge funds, private equity firms and the like. And you say, well, why did this happen? Why were we able to recruit those people? They're just amazing. I feel so fortunate to work with them. The pitch to them is this, if you love doing what we do, you love deep research, long term investing, we think we're a good home for you. You come in, you sit shoulder to shoulder with Alec and me in every research meeting, debating the entire portfolio, debating new names that you're pitching. And you can have an enormous impact on the future of Eagle. You're one of under 10 people, you can deploy a lot of capital and you have duration built into the model and you only have to pick one new name every year or two to be successful here. So your likelihood of success, given our resources and the time we give you and the ability to debate ideas shoulder to shoulder with all of us, I think is higher in this model. If you like doing this, we take you off the base plus bonus treadmill that you've been on and we give you an opportunity over 3, 4, 5 years to become a partner in an organization. And I think that's a differentiated value proposition. Because if you look at their lives, it's different than when I came out. You had more demand to hire hedge fund analysts in 2002 than you had a supply of them today. The seats are tougher. Capital has gone to indexing, it's flowed out of a lot of the long only space. There's less hiring there in general, fewer seats are going to be there over time and it's gone to systematic strategies and more pod oriented strategies. And the multi managers, a few of the big ones have just done a terrific job and they're great seats if you are good and want to do that specific thing. But the seats to do what we do aren't that many. That dynamic has grown over time and it's up and down the organization. Our head trader was at a big bank and then the head of trading for a top hedge fund. Before here. I never thought we'd have the scale to have one of the best traders. I think we do now. It's on the client side. We have terrific client people. I don't want to overstate this. This is a tough industry. There's not very big competitive advantages here. But if you think we have duration in the model, we have access to talent. The other part I'd marry that with is look at the management access side challenge. Imagine you're the head of investor relations at a big company. What's Your job, it's very similar to our client team's job. Our client team's job is to go and try to find clients who like what we do, want to partner with us, will give us duration, want to invest alongside with us, and will hopefully stick with us through our drawdowns, which we'll inevitably have. Investor relations job is the same, but to find shareholders, their challenge is maybe the top two or three shareholders often are going to be a Vanguard, State street or blackrock. And then the people getting capital and calling them often are long short trading frequently. Those companies have no incentive to spend time with those pods. They have a small incentive, but not a huge incentive. And the banks have a problem too because they sell management access and the big companies want duration in their shareholder base. And so they have this issue with the people that are paying the banks often to don't have duration in their shareholder base. In the same way, our access to talent has grown over time, our access to management has also grown. How many firms out there deploy 2 to 3 billion dollars in a company, hold it for up to 10 years? We're not activists. We focus on long term business issues. Of course we care about short term results like anybody else, but we really care about how companies are allocating capital and their business strategy in the out years. When we sell the stock someday, we send them a nice email often saying thanks for all you've done for us. It's been really great to be a shareholder and hopefully we'll have a chance to own that again. If your strategy is short term, the management access won't matter to you. But if you're going to hold the stock as long as we do, it can matter. And so you marry all this together and I think we have a bit of a right to win. We've given ourselves a shot to do a great job for clients and then it's up to us to execute and we like our hand.

D (23:48)

I want to pick apart some of the aspects of the business process and the investment process on this concept of paying salaries only and not bonuses is very different from what you hear commonly. What have you found are the subtle benefits of doing that?

A (24:05)

That's an interesting question. We're counter positioning in many ways against the multi managers who are paying terrific sums of money and hiring a lot of the best talent out there. Imagine we're trying to hire from a top single manager or a pod. The way those fee structures work at a single manager, they're charging a base fee and then an incentive at the end so their Earnings are lumpy. We don't have that issue as a firm. There's no reason we have to pay a base plus bonus because that's not how the partners are paid. Structurally, it's irrelevant to us. So the right question we ask ourselves is what's the best thing for the analyst in the firm? There's no proof that this is the right way to do it. It's just the way we've done it. If you're at a top fund, you're getting a base plus bonus. The way it actually works is you get your base salary, you wait all year long for your bonus, and you're thinking you can't focus on anything else at the end of the year. And then you get your bonus. And for one or two days you're like, okay, I got my bonus. And then you start thinking about your next year's bonus. So it creates a really acute, sharp focus on whenever the bonus season is. We wanted to push people away from that, number one. Number two, in our structure, the N is so low, they're not buying a bunch of new names over time. So to evaluate them on short periods of time when we want the investment case to play it out over three, five, seven years doesn't seem aligned. There's just also a couple practical benefits. They like it better. They get paid every two weeks. It's ratable. We don't defer them. And then it also makes it pretty hard to hire them. I think over time, imagine you're trying to hire one away. They have to think, what's the expected value of this low base plus high bonus structure versus if I do a great job here, I get paid ratably and then I get a chance to be a partner. The real tangible benefits organizationally, on the investment side, focusing on investing out over the right period of time. But I also think it's good to counter position against the big pots.

D (25:47)

When you started your career with this very wide opportunistic mandate, cross asset classes and geographies, and now it might be a little more narrow. You're just buying stocks. Where do you start thinking about where you want to look for ideas?

A (26:02)

That was a nice way of saying it. The reason everybody came into the hedge fund world, because it was so fun. You had this big mandate partnership vehicle, you could do anything you wanted to. That doesn't really exist anymore. In broad strokes, it's been diced up. You've got the distress funds, you've got the pods, you've got some single managers left, but there's not so much capital going to broad opportunistic mandates, it's become more specialized. I was having this debate with somebody recently talking about return streams over the last 10 years and we're proud of our record here. She made the case that, yeah, but you guys have that return stream because you're a large cap equity investor. And I said, hmm, I think you're saying that in a pejorative way. The truth is that's not the way Alec and I saw it. The way we saw it is we picked to do this. We thought the returns going back in time ex ante of larger domestic equities were really good return streams with very low risk and it was a great way to compound our capital personally and for clients, we picked that. So that's our personal selfish view of it. I know people can take issue with that. The starting point is can we generate absolute double digit returns over a long period of time? Think of us as absolute return investors living in a relative return world. We're modeling companies out 5, 6, 7 years looking at normalized free cash flow earnings per share, assuming a smart buyer is going to want to buy that from us and get an 8, 9, 10% return such that we assume a terminal multiple. That's fair. We look at the IRRs across our portfolio, across other companies and when we do that, the opportunity sets shift over time. Sometimes Eagle looks more growthy, sometimes it looks more value. It just depends on what that opportunity set is out there. To do what we do, we want to turn over the most amount of rocks possible to pick out these return streams. A good way to find those is where is capital flowing into where is capital leaving? So if we go back in time then compoundery type businesses were interesting after the financial crisis. And then I think people misunderstood the return streams of some of the big tech platforms. We were fortunate to identify some of those early on. We've always been pretty snobby about accounting here and so I think we understood the accounting of some of the intangibles early on, which was pretty fortunate. Today if we look at it, the return streams we're finding today are different than they were five years ago and 10 years ago. Before I pause on this, one story that always stuck with me is when I was back in my early days, I saw this record and it was like the best track record in hedge fund world you've ever seen. And I told somebody this is the best investor in the world, it's got to be, look at these returns. So self confident at that age. And the guy told me, anybody who has those returns in one year, they're taking some factor or some specific risk that is not going to be able to be replicated and it's just a matter of time. I've always taken that into account when we're trying to build our portfolio. What we're trying to do is have a portfolio of return streams that play out at different periods of time, different parts of their life cycle, with different factors involved so that we're not reliant on whether interest rates go up or down or the economy strengthens or softens or something happens in Taiwan. We think the base rate of getting that right is lower for us.

B (29:02)

We're going to take a quick break in the action to tell you about SRS Acquiam. Want to make sure your M and A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades. Instead, when it comes to M and A innovation, SRS Acium has reshaped the way that deals get done. Streamlining processes for maximum efficiency and minimum headaches. Professional shareholder representation, online MA payments, digital stockholder, solicitation. SRS acquisition pioneered each and continues to set the bar for game changing innovation. So leave the days of disjointed deal management behind and define your future with SRS Acium. The smartest way to run a deal. Learn more@srsaquium.com that's SRS A C Q U I O M dot com and now back to the show.

D (30:04)

When you dive into companies across that type of spectrum, you're thinking about five to seven year free cash flow analysis. There are certain types of businesses you might think of, value oriented type businesses that that's a stream of cash flows and you can measure the big tech ones that you've been in from time to time especially today that are spending massively on AI. How do you think about measuring free cash flow of a fast growing business?

A (30:31)

It's tough. The dream is to buy a franchise company with a huge moat at 14 times earnings. That's going to grow faster than nominal GDP forever. The world figured that out. TED Life is pretty tough if you go back in time and look at some of the big tech platforms. My only quibble with some of the asset allocation community is I like to think it was somewhat predictable 10 or 15 years ago that these companies would be able to scale globally with the Internet and be better return streams. If you looked at the structure of these businesses and what the Internet allowed, you could compare them. I Can see that the profitable businesses in these countries have this margin and the growth investments have a zero negative margin. You can see how the margins would play out. But to get that right, you have to believe the moat's in check. A couple thoughts on this. I believe all companies die in the end. It's just a question of when. When I see today the opportunity set and I see a lot of these formerly great businesses trade at 30, 35, 40 times earnings. I see a 2.5%, 3% free cash flow yield to get a double digit return. What do I need? They already have high margins. I need for them to be able to grow revenue maybe at organically 6%. Most companies don't outgrow nominal GDP forever and I need them to use their balance sheet a little bit and I need the multiple never to go down. And that's not my experience. If I buy a company at 10 times earnings on trough earnings that is going to grow earnings a few percent. I don't need much to happen to get double digit returns. One is not the better earning stream than the other. The way you construct an earnings stream for us is you look at the earnings or free cash flow yield, you look at the growth of that and then the multiple plus or minus. So on the tech side, on the AI bill today I think it's really tough. It is hard enough to identify what a big search engine is going to look like in three years, what the profit pool of that is. With the growth of ChatGPT, the idea that so many of these companies trade at high multiples seems hard to justify. Our best guess is some great companies will take out costs, make money on AI. There'll be a lot of that, but there'll be a lot of disruption. If this is right, the capex will be overbuilt infrastructure, highways, all these things. You ultimately in a capex cycle you just don't know if today you're in the third inning or eighth inning. So we're a little less comfortable with forecasting some of the big tech earning streams. You just have to be honest with yourself. Five years ago, SaaS companies, all these trading at 40 to 50 to 60 times revenue at one point today it's hard to give away a lot of SaaS companies. So there will be a lot of companies that look like obvious winners of all this that I think will be obvious losers. If we do our jobs well, we'll be able to find a number of names that will benefit from AI. We'll be able to find some in the middle that aren't obvious beneficiaries of AI that will take advantage of it, which we have some ideas there and then we'll hopefully avoid a lot that will get taken out by a.

D (33:06)

If you go back to your friend teasing you about, well, your track record's just large cap growth. When you have the opportunity to spend the time to dive in on a large cap company, what does that work look like to get your hands around something that presumably everyone has access to all the information on a big company.

A (33:27)

I grew up doing a lot of small cap stuff in mid cap. It is true, you can get better access and differential access. There's no sell side coverage or limited there. People aren't focused on it. The problem is that asset pool is not as rich as it used to be. If you looked at the small cap index today, it's a lot of biotech, a lot of unprofitable companies, a lot of the big conglomerates took out a lot of the best franchises there. Private equity owns some of them and then there just haven't been as many IPOs of those companies. It's not that we're dispositionally wanting to do large cap. I don't consider myself a large cap investor. We own some smaller companies. It's that in a world of AI tech change, globalization, these companies got to grow bigger and stronger and scale faster than we had seen in history. So the process of ripping them apart, it's a little different if we're being intellectually honest. Some of the big tech platforms, the founder doesn't go meet with us a lot, right? It's like they got better things to do. They're worth 100, $200 billion without taking my phone call. That said, we actually do get pretty good access to them. The easier companies to rip apart are the ones that are less oriented as conglomerates. Because if you buy a big conglomerate with 10 business lines, you're not going to rip apart every business line. But some of these big companies are very focused on individual areas. And so the research process here is first, could this be an interesting return stream? Why is it dislocated? Do we believe capital is flowing into this area or out of this area? Is it likely we're going to find an interesting return stream to start? What does the disruption look like in five or 10 years? If we were looking at a railroad, we would be debating self driving electric trucks. It doesn't always play out. We met with Astro Teller, the head of Google X, over 10 years ago. We were talking about self driving cars and we thought self driving cars are going to happen. So we avoided a lot of things thinking self driving cars are happening. So really what we want to know is is the base rate return assumption of the asset high when we're selling the stock out five, six, seven years, the next buyer is going to be looking at a few years. So we have to have a view on is it going to get disrupted in this time horizon. So that's the starting point and then it's all the normal stuff, reading everything. We can get podcasts on it, find the CEO, find anybody we know who's worked there, any executives there, tons of background research on the company and the executives looking at the executive compensation.

D (35:33)

When you have a portfolio that has some of those names alongside of clearly contrarian plays, curious how you organize your team to prosecute these very different opportunity sets.

A (35:47)

So this is something we've iterated and tried to learn at over time. We have a generalist framework. We're looking for outliers, but then within that we have a pragmatic specialization. It would be very hard to build a team if you started from scratch today of 10 very great senior analysts with just generalist frameworks because they're coming from single manager hedge funds often or pods where they had a specialization. So what we want to do is press within the analyst function when we notice an outlier. And so we want to be dangerous enough that we can notice outliers. And then when we do that, we want to spend an incredible amount of time doing deep research to make sure we're expert within that area.

D (36:24)

Once you dive in and start to get conviction in a company, how do you integrate the idea of where fund flows are going? And you could think about it as both the index funds kind of passive management and the pod shops on the other end of the spectrum.

A (36:39)

So I like the question. I'll accept it. My career starting in 2002 is very clear in retrospect that the markets were trending towards efficiency. I thought indexing was a big part of that for a long time. The easiest way to explain it to somebody who's not in the industry is you and I go into a poker parlor. There's 100 people around a table. You take out the 40 worst, which was indexing, and the remaining 60 is harder to beat. That makes it more competitive. Returns should go down. This actually happened in real life. I think maybe 15 years ago. I read a story about when the US made it so you couldn't play poker online. There were a lot of people who were making a Living here, playing against people in financial services who were having three beers at night, hobbyists or whatever, they were playing 15 hands at once and great poker players. So they were making a living. And when they could no longer play here, a lot of people moved offshore. Slowly over time, they were effectively playing against each other. And this is what our framework for investing had been one of the misnomers of what's happened to the active management world over the last 10 years. A lot of people think that this framework is what killed active management. Impossible to beat the market. The world was trending towards efficiency. That's why a lot of active management hasn't done well for the last 10 years. My framework's a little different for the last 10 years. Part of it is passive, made the world more efficient and the talent density running into the industry and the computers and the systematic traders and all the smart people. But part of it is really the opportunity set. I basically think mega cap technology killed a lot of the active management world. And the reason for that is pretty simple. If you study the history of alpha, you realize there's just different alpha pools at different times. And so if you're in a world where you're competing against a market cap weighted index, what happens is if you just look at the math of, let's say you were in a very, very concentrated index where the biggest weights were then up the most. It would be hard to beat that index if you didn't own any of those big tech weights. Imagine you had to replicate the performance of those by not owning them. It's very statistically unlikely you were going to beat all these big tech platforms that were scaling fast growing by not owning them. So your track record is impaired. Now let's just say you did own them. You over time looked more and more like the index. Your active share goes down, so the alpha dispersion gets slower. So is it a coincidence that a lot of the best hedge fund track records were created from the late 90s to 2010 and then a lot of them don't look great? Or is it a difference in alpha opportunity set? If you bring it up to today, what does the world look like? Where is the capital flow? Where are the opportunities? Indexes are sometimes really good, sometimes they're not. You go parts of Japan for 25 years, look at China, look at US was negative for over 10 years. Look at parts of Europe, emerging markets, they're not always great indexes. And so sometimes the index is really good and sometimes it's not. That's been magnified recently, I have a sneaking hypothesis that I'm hesitant to say out here because there's a high probability I'm wrong. But I will say it. I feel like the market's becoming a little less efficient in certain areas. And I'll explain it. Let's just look at the last five years and say, well, does that look efficient to you? Ted, what happened in 2020? There's all these fake companies at enormous multiples, spac bubbles, unicorns. It was a meme stock frenzy that didn't look so efficient in retrospect. You couldn't give away a cyclical company, so to speak. Two years goes by, 2022, what happens? Interest rates go up, Regime change. The whole world shifts. Tech stocks plummet. ChatGPT comes out. Tech stocks are back up. Now we have a meme stock. Crazy momentum factors off the charts. And you can't give away any of these companies that have unpredictable earnings streams. Right now I want to be very careful. This isn't easy to harness. It's hard to beat the market. But it looks to me like what's happening is the market is becoming a little more inefficient over the last five years in real time. And why might that be? When we talked about the world becoming more efficient from indexing, one of the things that I don't think was often discussed is there was this view that over time, how much of the world could be indexed? Could you have 99% of the world indexed? Could you have 90%? Nobody knew the answer, but the idea was in the end there would be these 10 smart funds setting the price of the market perfectly efficiently. It makes sense in an academic sense. But like most things in finance, ideas that make sense at the beginning become goofy at their extremes. So what if you got to that standpoint and you got to that state of the market? How would fund flows influence things? What if you had very few active actors and now a stimulus check came in and then there were a bunch of retail buyers of specific assets, but there's not liquidity there. How does that change the market dynamic? So what you have happening now is the market is indexing, the capital has flowed to multi managers and quant strategies or systematic strategies. A lot of these folks have done really well and their mandates are short term. And then you have this long only community under stress. They're shortening their time horizon. You have the sell side who shorten their time horizon to respond to the actors. And you look at all this and you say, oh my gosh, all the capital is flowing to a short term opportunity set. And then you see anything related to the momentum, the test of the times, AI power factors going crazy. And then you see these great compoundary businesses trading at 35 times 40 times earnings. And then you see these return streams over here that you can't give away. Okay, the path looks very uncertain, but the destination looks pretty good. Whose job is it to buy those? Where's the capital to buy those names? It's not because people are stupid. It's because if you don't know if you're going to be in a seat in two or three years, why should you do that? So it makes sense to me today that there is growing differentiation in those names out there. And it is harder to buy them because the return streams are imperfect and the path is uncertain. But in the end, what we're looking at is what's the entry multiple? Are we below mid cycle? How fast are earnings going to grow over time and what's the likely end state? If you go back 10 years ago, our portfolio looked more growthy. Today our portfolio is trading at enormous discount to the market because that's where we're finding the opportunities. And it makes sense to me conceptually that as the capital has flowed short term and the liquidity has gone down in many ways that the opportunity set would be shifting.

D (42:24)

What are some examples of situations where the path is uncertain but the destination you have more confidence in?

A (42:32)

Pull up our 13F, you'll see a lot. It's not fun. I don't want to be blase about it. You buy one of these things and it goes down every day. And every time we sell something that has momentum in it, it goes up the next day. Let's give a few random examples of what that could look like today without being too stock specific. So let's look at something in the headlines today, like SaaS companies. Everybody thought they were these great businesses and now today they're trading at low multiples on our view of normalized earnings. So what we want to know is what's the end state margin structure of a business? What does that mean? Stock comp you have to tax. And so a lot of these are stock comp pigs. So we care a lot about who's managing these. What's the retention rate of the business? How is the sales efficiency look over time? And then what's the natural end state of the margins of that? We have a view on some companies and so the reason they're trading cheaply is because AI now AI might be right AI might take out all these SaaS companies, that's a legitimate bear case. But it might not. You could look through that opportunity set and there's a lot of smart private equity firms still deploying capital there. And you could say are all of them going out or are there going to be some that survive? And they look like they're trading at very low multiples in a world that's paying very high multiples for quality businesses and these once were perceived as quality businesses. You can imagine things related to building products or home builders say I think there's a pretty clear consensus that homes are unaffordable. Home prices gone way up over the last few years, mortgage rates way up. We're under building the amount of new homes we need. There's this too strong bull case that we're under supplied by 3 to 5 million homes. Yeah, maybe, but you have to be able to afford them. So I don't really believe it, but I think it's pretty clear. A lot of these companies are trading at lowish multiples on below normalized housing starts. And it's affecting a lot of companies. Not all of them is a great opportunity set, but I think there are things in that space that if you close your eyes three to five years, the home building industry, the building products industries, there will be a better day ahead. And if you could buy some of them at trophy multiples on trophy earnings, that could be interesting. The one in the headlines today that they may work, they may not, but there's HMOs out there, the healthcare industry, there's a lot of pressure in Medicare Advantage, a lot of pressure. In certain segments the margins are way down. In certain areas the multiples are way down. These stocks were considered great companies 18 months ago, 24 months ago, compounders, some of them trading over 20 times earnings. High teens multiples today, are we at trough margins and are we at low multiples now that these dropped 40, 50, 60% some of them. And is the health care system likely to be very different in three years or are the margins likely to be higher? Are these likely to look better? And you have to get through the newspaper articles and all these other things, they're not easy to own. And so when we're buying things like this, this is in our whole portfolio. These are a few examples of things today that are hard to own. Sometimes it's hard to own mega cap tech. Sometimes it's hard to own things like this. I don't want all my portfolio in any one of these areas. I to want I want to have a portfolio of 25 to 35 things like this where the return stream's really high out five to seven years. And I know some won't work.

D (45:20)

When you see these opportunity sets coming up and then you do your deep dive work, but you're only buying a few names a year, how does that decision process work?

A (45:30)

Everybody wants to have this beautiful funnel slide where, hey, I look at this many names it feeds through. We got this great process that spits out the names. It's imperfect. Some of its fundamental analysis on irr, some of its judgment. I believe a bird in the hand is worth two in the bush. We have a dashboard internally and what we do is we pull through all of our companies and we look at the earnings models that we have internally and compare them against analysts sell side. We look where we're at a consensus out five to seven years. We look at analyst level conviction, we look at the returns that we expect relative to the volume of the asset, which is an imperfect measure. So if we have different return streams, if one of them is non cyclical, with a clean balance sheet, recurring revenue, great management, and it shoots the same IRR as another name that has all these hairy characteristics, I should be buying a lot of that first return stream. So what we're doing is we're looking at all the return streams possible and then we're saying, what are the best risk rewards? The portfolio isn't sized based on the highest IRRs. A lot of times the highest IRRs have the fattest tails to them. And so what they are sized by is a combination of judgment, IRR and just perception of risk reward. The bigger positions tend to be things with a lot of ballast in them, good balance sheets, good management. And the smaller positions tend to be things either we're entering or exiting or things that have fatter tails. The other aspect of this is given that we want to have a diversity of bets, if you bring in a new name, let's say we owned a bunch of something in a sector today and somebody comes up with a new name in there, it's going to have a higher bar. We prioritize more diversity of earning streams, we prioritize higher IRRs, we prioritize returns relative to the risk involved, and then we try to build a portfolio that will work in a broad set of outcomes that we can imagine.

D (47:12)

A few years ago you created, I think it was one of the first active ETFs, and we just love to hear the thought process of that structure and why that was somewhere you wanted to put your money?

A (47:25)

Yeah, sure. So we have to meet clients where they are. There's a lot of excitement about ETFs. People like it. People like being able to click a button. People like different attributes of it. So we were able to do it for clients. And I think the reception has been much higher than I would have thought. It's funny to hear people tell me, I bought your etf. I still am getting used to that. It feels different. But again, what we're trying to do is add value to clients, meet them where they are. A lot of people like this structure, and we want to have a resilient business. So I think of it as increasing the duration of the firm, giving clients another way to access us. And it's fun to be early on.

D (47:59)

Things as you look out over the next couple years. What do you think Eagle becomes from here?

A (48:05)

We're pretty simple. The firm is named Eagle. It's not named after any one person. Doing our job well means continuing to grow the talent side of the firm and continuing to attract great clients. If we can do that, I think we'll be able to out Alpha over time. There's no growth mandate here. We're big enough to hire who we need to hire and build this great firm that we think we built, but we're also small enough that we can still find interesting pockets of Alpha. It feels about the right size. We could grow a little, shrink a little. The North Star to us is really growth and excellence. That's what we're solving for. People focus in this industry on flows and all this stuff. I get it. But if our performance is up 15% or down 15%, that influences much more than anything else. So what we can solve for is talent, making ourselves relevant in the world and trying to build the excellence of Eagle. And I think if we do that, everything will play out well.

D (48:54)

What are some of the ways you're trying to improve the team, create that excellence going forward?

A (48:59)

We're trying to hire people that are better than me. And I think we've done that. I mean, it's pretty special. My wife was a kindergarten teacher. She's like, this is ridiculous. You get to meet with all these interesting people all day, work with these really smart people who are super talented, meet with management teams, and you get to learn effectively. I think I have the best job in the world. I get to learn all day long and work with these really talented people organizationally to increase the excellence. We recognize that every year that goes by, we have to get better and we're competing against these really smart players out there. It's making sure the management layer of the firm is thinking through all the ways we need to be able to track both capital and talent. On the talent side, it's how can we make this a great seat for them, a great career for them? And if we can continue to do all this stuff, I think a lot of the industry is falling away. We can get better while a lot of the industry is under siege. And if they keep shrinking their time horizons and we keep using duration and investing organizationally, then I think our wedge continues to grow. And that's what it's all about.

D (49:59)

As you look out on opportunity sets with this idea of seeing around corners, what do you have your eye on that may become the next interesting contrarian opportunities over the next couple years?

A (50:13)

I've always focused on the flow of funds. If you look at the last 10 years, the index has been great. That's been the place to be. I feel a little differently about it today. So I look at that like any asset. I don't want to tie it all back to what you said. So today I would look at that same asset and I'd say, okay, higher multiples, less diversified, more of a factor. Bet on AI and power. We've run the economy hot. Tons of fiscal deficit problems. If I just look at that, and you didn't tell me the name was the S and P index, I would say maybe whatever percentage of my money I had in that 10 years ago, I might want less today. That is how my brain would work. And then I would think, where do I want my money? And it doesn't mean you should give it to Eagle or private equity or private credit or Bitcoin or whatever. But it does mean as a starting point, we have to look at assets and valuations and how they change over time. I think the index is less interesting today. You put your money there for 50 years. I don't know, 8, 9, 10%. But the base rate of starting from here looks a little tricky now. AI could bail us out and productivity growth could go crazy. Who knows? I'm not bearish at all. I'm on it. I'm just saying it looks a little worse, the base rate to me. And yet it seems odd saying this because the NASDAQ and S and P keep setting new highs, but we're still finding things that we think are really interesting. But there's plenty of things that are flat or down over five, six, seven years out there that I think are interesting and at low points in their cycle. And so I go across all assets and say, okay, private equity, venture capital, private credit. In the same way, the hedge fund world was a great opportunity set 25 years ago, but the fees came in too. High fees and too much capital. The LBO world had a great opportunity set too. They had less capital there, they had lower multiples and rates came down. Looks to me like same thing. Lots of capital goes here, lots of smart people go here, and the forward return streams comes down. If you want to give me one of the top quartile of VC firms, you want to let me into Union Square Ventures or Benchmark, I'm in. So the top quartile of any asset class, generally I'm in. But I look at the base rates of the S and P index, I look at the base rates of LBOs today, I look at venture capital, I look at private credit. It's pretty tough out there. There's a lot of expensive assets. That's the challenge. If you look back at finance for the last hundred years, you have all these companies, you have the markets trend towards a liquidity, efficiency and low cost. Tight bid, ask spreads and marvel of the world, the US capital markets. It's odd to me that we're now shifted to a world where assets are staying private bid, ask spreads are wide, the fees are high, and I don't know how or when it all plays out. But in the fullness of time, hopefully in my career we'll see a change where I think these markets merge somehow. Interval funds are first step in that direction, secondary funds. So what I think is going to be interesting over the next three, five, seven years is parts of Asia, Japan, Korea could be interesting. There's parts of the VC world that I think are pretty interesting. There's no money in Biote. It's harder to raise money in the active equity space, harder to raise money in the private equity space. It's hard to raise money in a lot of areas. And so you're going to see opportunities as a lot of these private companies have to find ways into the market. What I hope is going to happen is you'll see a number of younger smart managers who would have been in the hedge fund world start long onlys at lower fees that'll make that opportunity set richer. And I think people will focus more there. But the world's pretty expensive.

D (53:23)

All right, Adrian, I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family?

A (53:31)

My Two passions in life are my family and business and I've oriented my life to spend time there and it crowds out other things. But one thing I do have a passion for are rom coms. I'll die on the Hill, that romantic comedies are criminally underrated. And you look at these rotten tomato ratings, 25, 30% it seems crazy to me. I've never seen one I don't like. I just think they're mood enhancing. So if you think about it, you click play. The world stands still, everything's a little quiet, my brain shuts down, a smile comes across my face because I know it's going to have a happy ending. That's great.

D (54:03)

Which two people have had the biggest impact on your professional life?

A (54:07)

My father's love of business and my parents love of a good deal impacted my life. The founder of Eagle, Ravenel Curry gave me enormous opportunities and trust at a young age for which I'll forever be grateful and changed my life. And he's just a terrific entrepreneur and long term thinker. So it's been a wonderful to spend so many years with him. But the person by far who's impacted my life on a business sense is my partner, Alec Henry. So I met Alec a couple decades ago in the investment world and we've been talking daily or almost daily ever since. And we talk about everything from financial markets to the psychology of sales to are cold plunges actually healthy? It's everything. Well, I'll tell you about Alec is. He's brilliant, he's very sharp, he's curious, he's kind and he's one of these people that always does the right thing. And if you surround yourself with somebody like Alec, it can't help but bend you in a good direction. I like to think he's had that impact on me. If you find somebody that you respect, that you have mutual admiration for and you like to get to the answers of things and debate things and you can do it behind closed doors. The amount you can learn is off the charts and it's even a little bit better than that. Tip. So Alec is articulate and concise, so he says really smart things very quickly. So when we talk I learn a lot but I also get to speak more than half of the time. So we call that a twofer.

D (55:26)

What brings you the greatest joy?

A (55:28)

It's by far putting my 10 year old daughter Maisie and 5 year old daughter Callie to bed. It's the time of day where the house is quiet, everything slows down. They are so chatty and Hilarious and goofy, and we're goofy together and dancing and singing and playing pranks and reading or what have you. And so what if bedtime takes an hour? And the most fun part of it all is when we push just long enough that my wife, who is the most patient human being I've ever met, turns her head at me and looks at me a little bit and says, adrian, are you ready for some constructive criticism? I think you could use some help with your bedtime skills. I say, the only thing better than one daughter is having two. And I think I'll always remember the bedtimes, and I hope they do too.

D (56:12)

What's a mystery you wonder about?

A (56:14)

I wonder about all the normal stuff, like are we in a simulation afterlife, how are the pyramids built? All that stuff. In wonderment, I often think about how my life could have ended up very similarly to this. Growing up in different states or different colleges or different first jobs. These two most valuable things in my life. My children. How a very specific pattern of events had to play out for them to be here. But if you really want to know the answer to this, if I'm sitting on my bed at night rolling around and the thoughts I wonder about, how many non alcoholic beers can I have per alcoholic beer before the placebo effect wears off? I wonder whenever I go to a white elephant gift exchange party why people are the worst versions of themselves. I think about a lot. What a high percentage of a dress shirt's total cost to spend on dry cleaning. And then when I go back to Texas, I wonder why people think line dancing is fun. And I also wonder on the way why people think word finds are fun on the plane.

D (57:05)

All right, Adrian, last one. How's your life turned out differently from how you expected it to.

A (57:10)

Glitter. Lots and lots of glitter and stuff. So much stuff. Amazing Cali love stuff. I didn't expect any of this. I just remember the goofy teenager who was immature and comically competitive and had a subwoofer in his car and had a shrine to Michael Jordan and sold Cutco knives and worked at the local shoe store for minimum wage. I had a lot of room for improvement. I met my wife, Jennifer when I was very young, waiting tables at a moderately priced Mexican restaurant in Texas. And it was love at first sight for me. And so we didn't have any money back then. I remember we would go to Sam's club to buy calling cards to call each other because cell phone were so expensive. Or we would pool money to visit each other. Getting to grow up with somebody who's as wonderful as her, who offers you relentless emotional support from a young age and is your biggest fan. You can't replace that. I don't think I'd recommend it to people marrying somebody you date so early. It just doesn't make mathematical sense. But if you do and you get it right, there's just a lollapalooza to it. The way I describe it to people is sometimes our two daughters do something and it just makes us smile and we don't say anything and we look at each other and I think what we're both thinking is, gosh, this really worked out in the end. How cool. I would never expected to find my spouse and my soulmate so young. I would have never expected to only have two jobs after college so far and be afforded unusually good opportunities at a young age. I would never have expected to live in the Northeast. And if I think about it all, it's very unusual in life to be able to spend your lifetime at home and at work with people you love and admire. And for that I'm truly grateful.

D (58:45)

Adrian, thanks so much for sharing your insights.

A (58:47)

Thanks for having me. Ted.

B (58:49)

Thanks for listening to the show. To learn more, hop on our website@capitalallocators.com where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one and see you next time. All opinions expressed by TED and Podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.